Final Act in Loss Mitigation Insurance Episode

In the final act in the unfolding of a scheme to use "insurance" to misrepresent the financial statements of Brightpoint, on May 25, 2007, a civil jury found against Brightpoint’s former risk manager, Timothy Harcharik, on claims of aiding and abetting civil securities laws violations. (Refer here and here for news coverage.)

The case against Harcharik arose out of events at Brightpoint involving losses at its UK division. According to the complaint (here) the SEC filed against Harcharik and others, in October 1998, Brightpoint announced that it would be recording a loss of $13 to $18 million because of the losses in the UK division. However, as the quarter unfolded, it became apparent that the loss would be as much as $29 million.

According to the complaint, in order to find a way to avoid reporting a loss larger than the $13 to $18 million announced in the October release, Harcharik and the company’s Chief Accounting Officer, John Delaney, contacted the Loss Mitigation Unit of one of American International Group’s insurance subsidiaries. The parties agreed to develop a policy that essentially required Brightpoint to pay $15 million in premium in installments over a three year period, for which the company would recover $15 million in loss payments. The policy, finalized in January 1999, enabled Brightpoint to report an insurance recoverable to be netted against the UK losses, bringing the net loss to within the $13 to $18 million range. According to the complaint, Harcharik and others specifically negotiated the contract and the documentation to accomplish the desired accounting objectives.

Following an SEC inquiry, the company’s auditors examined the transaction and Brightpoint ultimately announced two successive restatements, following the second of which the transaction was accounted for as a deposit rather than as insurance.

The SEC filed a civil complaint against Brightpoint, AIG, Harcharik, Delaney, and Brightpoint’s former CFO. According to the SEC’s Litigation Release (here), the transaction was simply a "round trip" of cash from Brightpoint to AIG and back to Brightpoint, but because the premium was spread over three years it enabled Brightpoint to spread a loss over the three years that should have been recognized immediately. According to the litigation release, the other defendants all agreed to settle the civil allegations, but Harcharik elected to contest them. News coverage of the civil case filing can be found here. Harcharik was also separately charged criminally for giving false testimony in connection with the investigation of the transaction (refer here), although the indictment was later dismissed on the grounds of improper venue (here)

In the May 25, 2007 verdict, after a week long trial at which Harcharik chose to represent himself, the jury found against Harcharik on three counts of aiding and abetting securities fraud, but the jury found in his favor on another aiding and abetting count and on a count of securities fraud. The court will decide Harcharik’s penalties at a later date.

AIG for its part, according to the SEC's litigation release, agreed to pay a $10 million civil fine for the Brightpoint transaction, part of a total of $126 million AIG agreed to pay in November 2004 connection with investigations surrounding the Brightpoint transaction and a separate deal involving PNC Financial Services. AIG's press release can be found here, and related news coverage can be found here.

The Brightpoint episode is only one of several so-called "finite" insurance transactions that authorities have been investigating. For example, the SEC has also filed civil charges (here) against three officials at Renaissance Re Holdings, alleging that they had "structured and executed a sham transaction that had no economic substance and no purpose other than to smooth and defer over $26 million of Ren Re's earnings from 2001 to 2002 and 2003." Ren Re itself agreed in February 2007 to pay a $15 million fine to settle the civil charges against the company (here).

The invocation in the Brightpoint episode of the phrase "loss mitigation insurance" resonates with the echoes of an earlier time in the insurance industry, many of the associations of which are quite far afield from the kind of transaction in which Brightpoint was involved. In the late 90’s and in the early part of this decade, just about every industry conclave included some discussion of loss mitigation insurance as a way to provide additional retroactive excess insurance protection for securities claims that had already been filed. You just don’t hear anything about this sort of thing these days, no doubt for many reasons, including in particular the current general high level of scrutiny surrounding all forms of "finite" insurance and reinsurance transactions.

It certainly appeared at the time that many of these loss mitigation policies were being written in connection with then-pending securities claims. I have always wondered what the results for this product line ultimately wound up looking like. Given the dramatic escalation of securities class action settlements that has occurred in recent years, I have to surmise that the results were not favorable, which may provide another explanation why you don’t hear much about these kinds of policies any more.

More About the Tyco Settlement: In an earlier post (here), I wondered about the D & O insurance contribution to the recent massive Tyco class action settlement. A May 25, 2007 issue of Business Insurance (link unavailable) provided the following additional information:

Sources, however, said that Tyco can apply the bulk of its $200 million of D&O coverage to the settlement. The remainder has been used to cover the legal costs of former Tyco officials who have not been convicted of crimes for their roles in the scandal, sources said.

Warren, N.J.-based Chubb Corp. leads the coverage. American International Group Inc. of New York and Bermuda-based ACE Ltd. participate on excess layers, sources say.

Chubb unit Federal Insurance Co. filed suit in New York state court in January 2003 in an effort to rescind its coverage, arguing that Tyco had obtained coverage on the basis of fraudulent financial disclosures. But Federal halted that effort five months later, after Tyco paid a total of $92 million of additional premium to its D&O insurers to maintain and extend coverage (BI, May 19, 2003).

Tyco's D&O coverage would amount to less than 10% of the cost of
the company's settlement, which must be approved by a court. But, the settlement
still results in a full-limits loss for the D&O market.